What Happens If We Just Let the Housing Market Crash?

Should the government let the bottom fall out of the housing market? It sounds catastrophic, but on Sunday, The New York Times reported that the argument in favor of this move is gaining popularity. The Washington Indpendent's Annie Lowrey summed the idea up succinctly as this:

The
government has done a lot to ensure that home prices do not slide too
precipitously. But houses are still too expensive--and if the
government were to pull its interventions, prices would drop, ginning
up sales.

The article has drawn a number of skeptical responses. Is letting prices crash really the best way to approach the problem?

Between the Devil and the Deep Blue Sea On the one hand, writes economist Tyler Cowen,
there is a limit to "how long ... the government [can] prop
[mortagages] up." But if "we let them fall," that might send banks
"underwater" again. As a result, "our government would end up nationalizing these
banks and it still would be on the hook for their debts," while "the
blow to confidence would be a major one." He decides "there is no easy
way out of this dilemma," calling it "a major reason why the U.S.
economy remains stuck. Housing prices must fall, yet...housing prices
must not fall."

Let Prices Fall "I don't see how we can continue the charade of government policies to prevent the inevitable," writes Veronique de Rugy
at National Review. "We must let the market clear," she continues,
using the common term for what might more or less be translated as
"reset." While "there is a risk," she acknowledges, responding to the
standard criticism, "nothing can prevent it."

But
Doing That Could Prolong and Worsen the Recession "The real costs of
falling home prices are obvious, likely, and severe, while the benefits
are vague and speculative," counters economics consultant Adam Ozimek
at Modeled Behavior. "In Q1 2010 there were millions of homeowners who
are in a negative equity position. If prices fall another 5%, each of
these bars will shift to the left one position." Lowering prices,
therefore, "will drive a wave of foreclosures. The best evidence
indicates that foreclosures, in turn, will decrease nearby home values
by 1% to 2%, which could exacerbate the foreclosure blights many
neighborhoods are already facing." Ozimek directs readers to Ben
Bernanke's renowned (in the world of economics) paper on the Great
Depression, in which, among other arguments, he suggested that
"defaults and bankruptcies" have a way of deepening depressions.

Is the Government Even Propping Up Prices? "The housing tax credit has expired," points out The Economist's Ryan Avent.
"Interest rates are low, but interest rates don't explain all that much
of the movements we see in home prices." Tyler Cowen, he decides, is
talking about "continued purchase of mortgage debt as the key
mechanism" for propping up the market, but he's not sure there's a
direct connection between that and prices. With so many homeowners underwater on their loans, letting prices fall would only increase the number of homes in a "negative equity situation" worsening "the downward pressure on prices." "Let prices go where they will go," he concludes. "The
problem is in the huge pile of mortgage debt that is no longer
supported by home values."

We Are Propping Up Prices, and It's Time to Stop, suggests finance professional and blogger Barry Ritholtz,
who says he has been arguing just this "for several years." His
explanation: "Its not a crash that is needed--it is merely allowing
prices to revert to their historic levels."

In Other Words, Let's Mess with Millions of People, translates liberal blogger Marcy Wheeler. The upshot of the New York Times article, she says, is that "the housing industry would like a reset that will likely doom millions of Americans."

This article is from the archive of our partner The Wire.

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